Funding 101 Part 7: Friends & Family

FamilyIn the 7th part of her excellent series about funding, Elizabeth Crowell looks at networking and approaching friends and family as a source of investment. To read Part 6 of the series, about Venture Capital, click here.

We started this series talking about bootstrapping, and in short order progressed to the rarefied world of venture capital. But I want to take a step back, and remind founders about a potential source for funding: their friends and family. And although I discovered a roughly 50-50 split among entrepreneurs and investors advising for and against friends and family funding, the numbers speak for themselves. “According to the Global Entrepreneurship Monitor (Babson & London School of Economics), upwards of $50-$75 billion dollars is invested annually by friends and family in US startups. That is about 2 to 3 times the amount invested by venture capitalists and angels annually” (Bill Payne & Associates – Enabling Entrepreneurs). Clearly, it's an option to consider.

Raising capital from friends and family has its advantages, primary of which is that these potential investors know the founders very well; and that takes a lot of legwork out of the fundraising process. Also, they may be willing to loan the founder money, rather than take an expensive equity stake.

Since equity may be one of the only bargaining chips a founder has down the line with other investors, preserving as much of it as possible upfront is an added bonus.

But don't be fooled that this money is "easy" or that this is a "shortcut," because one of the disadvantages of getting friends and family involved is potential downside of losing someone else's money. It could very well strain a vital relationship or even destroy it. Typically, your relatives are not professional investors and may not fully understand that there is a high probability that they will never see a dime of their money again.

The best way to prevent this from happening is to treat friends and family like any other investor, and seek expert advice and assistance on how to craft the Friends & Family offering. If your accountant or attorney has securities experience, have her draw up an agreement that details the terms of the investment. Prepare a business plan just like you would for the bank, and conduct yourself professionally by being upfront about the risks and opportunities. In many cases, the investment will be in the form of convertible debt, which is a long-term loan without a monthly repayment schedule, but with the investor upside of converting to equity, should the opportunity present itself.

Many founders assume friends and family means ask your rich relative to underwrite your venture. If you have that rich relative, go for it, but don't be deterred if you don't. You may still be able to leverage your family for contacts; your family need not be wealthy to have a friend or two who is. Even if your family's contact isn't interested in investing, perhaps she knows a person or two who would.

You are probably getting the idea by now that networking is essential to building your business and you might as well start with the people who know you best.

Don't limit the conversation to funding; be open to finding a connection who can provide expertise in some valuable area where you are lacking.

Feeling uncomfortable about how to begin? I highly recommend a book entitled Link Out: how to turn your network into a chain of lasting connections, by Leslie Grossman. Speaking of networking, I offer the example from my own portfolio as proof positive that you never know who could be a potential investor.

Several years ago, I was on the advisory board of a cultural organization in Manhattan that was evaluating an opportunity to take over the lease of a local coffee shop. Being a retailer, I was sceptical that the organization understood what a significant undertaking they were considering. But since I didn't have direct food/café experience, I decided to connect the organization with someone who did; a local ice cream parlour, run by a fellow business owner in my neighbourhood. I had recently discovered that a personal friend knew the owners of the ice cream shop – so between her introduction and the fact that we were "peer" business owners, I was able to ask their advice about how to analyse the café opportunity for the non-profit.

I was hopeful that I would be able to arrange a call and get some broad strokes and red flags to avoid, but I was floored when the company shared a detailed analysis of all of the factors they would consider when evaluating new retail locations. I immediately recognized that this ice cream parlour was more than just a hobby pursuit. This was a business with crack-smart founders, in knee-deep with numbers, and thinking about how to scale and grow the business.

While thanking them for their time and insight, I mentioned that if they ever decided to seek outside capital, I would be willing to review a prospectus. Sure enough, about six months later, a prospectus arrived, and in short order, I became a friends and family investor.

Thinking out of the box, whether it's for seed capital or problem-solving, is the hallmark of a successful entrepreneur.

Treat it like a muscle: practice, practice, practice – and watch it strengthen and grow. Start by committing to connect with at least one friend or family member this week about your business vision, and you are on your way.

Elizabeth Crowell is the co-owner of Sterling Place, a multichannel retail company that sells eclectic antiques, fine home decor and specialty gifts. Profitable from year two, the business has steadily grown, with two store locations in Brooklyn, as well as a website. Sterling Place has been profiled by the NY Times and Elizabeth has been a repeat guest expert on Martha Stewart Living Radio. In 2011, Elizabeth was selected as one of 10 in the inaugural class of Pipeline Fellows, a program designed to train women to angel invest in women-led triple bottom line ventures, ie. profitable, environmentally responsible and delivering social impact. She is in the process of building out her own angel portfolio. For more information on Elizabeth, see her profile.

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